A petition filed by some unhappy investors on Tuesday raises some serious challenges to the so-called Bank of America mortgage settlement. The embattled bank hopes to shed liability for alleged misrepresentations made by Countrywide on loans sold in 530 mortgage trusts with $424 billion in par value. We said it was a bad deal for investors because, among other things, it included a very broad waiver of a very valuable right, that of being able to sue over so-called chain of title issues (in very crude terms, whether the parties to the deal did all the things they promised to do to convey the loans properly to the mortgage trust).
This action raises three sets of different issues: the conflicts of interest among the parties trying to push this deal through, the process used to finalize the deal, which this pleading contends were devised to give the other investors short shrift; and the inadequate amount of the settlement, not only for parties that have tried to move their own putback litigation forward, but arguably for all parties.
The biggest challenge, in the court of public opinion as well as presumably before the judge, is the idea that this is not at all an arm’s length transaction, and that the trustee, Bank of New York, is effectively engaged in self-dealing, selling out the investors to save its own hide. To put it more simply, parties that are presented as representing the investors’ interests are actually working to advance the BofA cause.
Bank of America gave the Trustee, Bank of New York, a side letter than indemnifies it for all liability incurred in entering into this deal. That means if any investors are unhappy, the costs are borne by BofA (the party that benefits from this settlement) not Bank of New York, the party supposedly representing the investors.
As the lawsuit drily notes:
It is very unusual, to say the least, for a trustee that says it is representing the interests of the beneficiaries of a trust, to demand and obtain an indemnity from the very party that is adverse to that trust and its beneficiaries (in this case, the certificateholders). BNYM concedes in its petition that it was concerned about its liability for the way in which it was handling (or, more accurately, ignoring) the demands of its beneficiaries that it take legal action for their benefit against Countrywide and Bank of America.
But it goes further: the side letter also indemnifies the trustee broadly against liability in the pooling and servicing agreements, the contracts that govern these deals. Since trustees like Bank of New York provided multiple certifications that the trusts held the assets (and that would include observing the chain of title niceties) when lawsuits all over the country have established that that did NOT happen. In addition, a senior Countrywide employee in testimony in Kemp v. Countrywide said Countrywide had retained the notes (the borrower promissory note) when the trust was supposed to have them. Whoops!
So the trustees have a ton of liability the are eager to escape. And that means that the indemnification in the Bank of America side letter is tantamount to a very big bribe to Bank of NY to go along with this deal.
Now why would investors agree to that? After all, aren’t 22 investors along for this ride? Let’s query how independent they are.
We had thought that Blackrock, which was formerly 49% owned by Merrill, which was then absorbed by Bank of America, was independent when this deal was struck. The buyout by Blackrock of its final shares had been set on May 19 and was expected to close June 1.
Funny, the lawsuit now tells us that the disposition of the remaining interest didn’t close until July 1, two days after the settlement deal was inked. Awfully convenient timing, no?
Readers have pointed out the New York Fed is hardly an economically-minded investor (otherwise, it wouldn’t have hoovered up dreck assets to save undeserving banking behemoths). Fannie, another party to the deal, is in conservatorship and its primary objective is to prop up the housing market. Its minders in the Administration might deem throwing Bank of America a bone (more like a side of steak) to be good for Obama’s image with Wall Street (or conversely, that they don’t want to take the risk of opposing or merely sitting out the deal). Goldman (admittedly, Goldman Sachs Asset Management) might also deem it to be wise not to ask too many questions about a deal that could serve as a template for other deals that would get it off the hook. I’m not certain why Pimco would go along, but it is awfully (as in troublingly) close to the Fed.
The rationale for the other investors may simply be that they never intended to sue on putback issues, so any money looks like a freebie to them. But the flaw in that reasoning is the broad release. They are effectively trading a barely out of the money option for free.
Foreclosures are going at a snail’s pace due to all the “paperwork” problems, which really means the screwed up chain of title issues which make it at least costly and in many cases impossible for the trust to foreclose if the borrower challenges it. And as more borrowers are getting savvy and fighting if they can’t get a mod (and services are still not very keen to give mods, their recent PR efforts notwithstanding) loss severities (losses as a % of original value) are going to skyrocket. They are now around 50% for prime loans and over 75% for subprime. Higher loss severities are not reflected in current RMBS prices.
When the market wakes up and RMBS prices ratchet down, investors may decide to go after the parties responsible for this mess, if nothing else to force principal mods, which are cheaper than being stuck with loss severities on certain mortgages in excess of 100% (whIch I’ve seen happen on contested deals, legal costs can easily exceed the value of the house in liquidation).
Another reason investors may have been asleep at the switch is they may have been persuaded by the lawyer who is allegedly working for them, Kathy Patrick. Earth to base, her $85 million fee is being paid by Bank of America. She is working for the deal, and Bank of America was not interested in a deal unless it was plenty favorable to it.
As one structured credit attorney who is not working for investors on this or any other putback deal wrote me to say that Patrick should be disbarred for her conduct on this transaction. Even if she has obtained the waivers from the major participants regarding her conflicted role, he argued that it’s preposterous for her to claim she is representing the investors in 530 trusts when it is certain in most, perhaps all, the 22 investors she has signed up do not represent 51% of the interest.
That brings us to the second point, the questionable procedures involved. We’ll address this more briefly. The petition is from some investors who were pursuing putback claims on three of the trusts in this deal. Their interests were known. Not only had they demanded that the trustee, Bank of New York Mellon, put back the loans, but when ignored, they sued the trustee and that litigation is pending:
BNYM nevertheless made no effort to inform Walnut Place or the hundreds of investors in Countrywide trusts other than the 22 self-appointed investors that BNYM was secretly negotiating a deal with Countrywide and Bank of America, much less to solicit the views of those investors about what terms of settlement would be fair or whether they wished to be “represented” in those negotiations by the 22 self-appointed investors.
The petition also argues at some length that the Order to Show Cause filed by the parties to the settlement (Bank of America and the Bank of New York Mellon) does not provide a mechanism for certain trusts to be excluded from the deal and can only provide “written objections”. They note:
It is unreasonable to expect certificateholders to wait until the final approval hearing on November 17 before knowing what conditions they must satisfy to exclude their trusts from the proposed settlement and whether they have fulfilled those conditions. At the very least, certificateholders that object to the settlement must have sufficient notice that their request to be excluded has been denied so as to permit them to challenge the settlement in other ways.
This is legalese for “the non-participating investors are being railroaded.” I’m told by someone who has investors contacts that a lot of other investors in these trusts are decidedly Not Happy. And the reading of MBS Guy, who looked at randomly selected Countrywide pooling and servicing agreement (CWABS series 2006-10) supports that view:
The provisions on the trustee and certificates generally talk about affirmative actions. I don’t see anything that indicates the trustee can waive the rights of certificateholders who don’t agree to the provisions. Practically speaking, however, if a large portion of the certificate holders agree to the settlement, it would foreclose the possibility of any other lawsuit in all likelihood.
In section 8.13, Suits for Enforcement, the trustee shall act to enforce or protect the rights of the certificate holders upon the direction of 51% of the certificates. This is a higher threshold than the 25% required for certificate holders to initiate an action, as provided by section 10. 08.
Importantly, according to section 10.08, certificate holders suing the trust do not have the right or ability to
affect, disturb or prejudice the rights of the Holders of any other of the Certificates, or to obtain or seek to obtain priority over or preference to any other such Holder or to enforce any right under this Agreement, except in the manner herein provided and for the common benefit of all Certificateholders. For the protection and enforcement of the provisions of this Section 10.08, each and every Certificateholder and the Trustee shall be entitled to such relief as can be given either at law or in equity.
I interpret this to mean that the rights of the certificate holders who don’t agree to this settlement should not be adversely affected or waived if they don’t agree.
Finally, there is the question of whether the $8.5 billion is remotely adequate. Given that Bank of America had formerly resolved to fight this type of suit tooth and nail, and the investors had done nothing to develop litigation, the Bank clearly must regard this suit as a screaming bargain to have reversed itself so decisively. And the petition points out that the investors on the three trusts had spent hundred of thousands of dollars in investigation and had determined that there were substantial rep and warranty breaches in these deals, as high as 66%., or $242 billion across all the 530 trusts. The usual rule is the more you do to build a case, the more you are likely to obtain in a settlement. We’ve long been skeptical of rep and warranty suits because they cost so much to build, but the low settlement amount (even by our jaded standards) shows the willingness of the attorney to maximize the return on her time rather than the result for her clients.
This may simply seem to be a fight among what ought to be consenting adults, but letting the TBTF banks off the hook for liability, failing to reform securitization practices (the measures in this settlement are either cosmetic or affirmatively bad for homeowners), and dumping the damage on investors eliminates one of the biggest leverage points, the risk to the financial system, that can force the key actors (including complicit regulators) to come up with remedies. Allowing the banks to escape not only rewards their bad conduct, it will also assure a significant overshoot to the downside in this housing market correction that will hurt consumers and the economy generally.